Corb7 International April 2012 Newsletter

Tax & the Evil Tax Haven: A Historical Perspective

By Jeff Corbett

Tax day in the United States is right around the corner. With April 15th looming for many, it seemed an appropriate time for us to take a brief look back at the origins of tax and the inevitable tax haven model. Both issues are intertwined and often misunderstood. Tax day in the United States is always an inauspicious date. Every April 15th millions of otherwise upbeat and proactive citizens wait to the very last minute before submitting to inevitable long arm of the taxman. Entire cottage industries of tax attorneys and Certified Public Accountants owe their very existence to this date. So, we again take our annual look at the history of tax.

In 1988 the Rolling Stones explained why they left England to Washington Post writer, Richard Harrington, for his article entitled “Stone Free”. “In 1971, we were forced to make a decision courtesy of the British government – live in England and (because of high taxes) not be able to afford another set of guitar strings or move and keep the band together. Hence, the album “Exile on Main Street”.

Let me tell you how it will beThere’s one for you, nineteen for me
‘Cause I’m the taxman, yeah, I’m the taxman
Should five percent appear too small
Be thankful I don’t take it all
‘Cause I’m the taxman, yeah I’m the taxman – The Beatles “Taxman”

It may be surprising to discover that taxes date back more than 5,000 years. Virtually every society that has ever existed established a tax system. It is also unfortunate that – throughout the course of history – cruelty and terror have frequently been linked to the collection of these same taxes. Thus, the desire by individuals throughout the ages to avoid tyrannical behavior forged a predictable and common mindset. To protect their wealth and freedom, people have historically gone to great lengths to seek refuge in havens.

Egypt, Rome, and the New World

As early as 3,000 B.C. ancient Egypt taxed its citizens. Within their system, the Pharaoh empowered Scribes who were enormously powerful tax collectors. It was not uncommon to find scenes depicting the Scribe’s often ruthless actions in Egyptian drawings. There were a vast array of taxes which people paid with in goods or labor since coin had yet to be invented. Each individual or family paid according to the skill they possessed. For example; craftsmen donated products, hunters supplied food and so on down the societal line. In addition, every single household – no matter its financial standing – had a labor tax obligation. The collective was expected to meet this duty by donating physical work towards the building of mines or canals. To that end, many wealthy citizens annually enlisted and paid the poor to relieve them of these responsibilities.

In antiquity – the broad period associated with the interlocking civilizations of ancient Greece and ancient Rome which is also commonly referred to as the Greco-Roman period – public contractors were often engaged to be tax collectors, manage the collection of port duties and oversee public building projects. Later, during the Roman period, revenue chests of the Roman Senate were greatly enriched by taxing conquered territories. “In this same era, hordes of Roman taxpayers went over to the Barbarians to avoid Rome’s oppressive tax enslavement. Perhaps even more unexpected during the seventh and eighth centuries Islam was considered a tax haven to the Christians. More recently, the first tax haven in the post-medieval world was America. Historians readily acknowledge that more people fled to the new world to avoid Europe’s hated new tax than for religious, political or political freedom.”[1]

Many present day financial centers located in the Caribbean and South Pacific which are commonly referred to as tax havens were at one time British Empire territories. This is not by accident. It was widespread for British aristocrats to seek asylum from harsh tax for their own wealth in far-away lands. In fact, most would agree that British trust law, the foundation of most modern day tax haven legislation, dates back a minimum of 400 hundred years and has its origins here. “The trust concept which originated in England was then transplanted to The Cayman Islands in 1727 with accession of King George II to the throne.”[2] From these beginnings, the trust document gained popularity and spread throughout the British Colonies and eventually the world.

Too Much Tax Creates Tax Havens

Rising tax rates and an increase in currency controls by one government invariably result in another country opening its doors wider to foreign investment. This is the essence of a tax haven. First and foremost, it provides a safe harbor. “A tax haven is a place of shelter or refuge from taxes, particularly high income taxes and death duties. It is not material whether a country is a tax haven by accident or by design. Some countries are tax havens simply because they never got around to imposing taxes.”[3] These jurisdictions typically have stamp or sales tax in place of income tax.

“My fortune is in the Bahaman Islands and it’s going to stay there as long as that bastard is in the White House” – Quote attributed to an American financier speaking about then President Roosevelt during a period of high tax

Adam Smith, author of The Wealth of Nations, a classic economic work, made his position clear pertaining to tax and its collection. “Every tax ought to be so contrived as to both take out and keep out of the pockets of the people as little as possible, over and above what it brings to the public treasury of the state.” He further goes on to give four reasons why the State should avoid this folly.

First, the levying of it may require a greater number of officers, those whose salaries may eat up a larger part of the produce of the tax and whose prerequisites may impose another additional tax upon the people.

Secondly, it may obstruct the industry of the people and discourage them from applying to certain branches of business which might give maintenance and employment to great multitudes. While it obliges the people to pay, it may thus diminish, or perhaps destroy, some of the funds which might enable them to do so.

Thirdly, by forfeitures and other penalties which these unfortunate individuals incur, those who attempt unsuccessfully to evade the tax, it may frequently ruin them, and thereby put an end to the benefit which the community might have received from the employment of their capitals. An injudicious tax offers a great temptation to smuggling, but the penalties of smuggling must rise in proportion to the temptation. The law, contrary to all ordinary principles of justice, first creates the temptation then punishes those who yield to it. It commonly enhances the punishment in proportion to the very circumstances which ought certainly to alleviate it, the temptation to commit the crime.

Fourth, by subjecting the people to frequent visit and odious examination of the tax-gatherers, it may expose them to unnecessary trouble, vexation and oppression. Although vexation is not expense, strictly speaking, it is certainly equivalent to the expense at which every man would be willing to redeem himself from it.

Income Tax in the United States

The abuse by tax collectors Smith spoke of is historic fact. Concepts of income tax have been changing in the United States, as elsewhere, for hundreds of years. “President Lincoln established the Bureau of Internal Revenue in 1862, the direct predecessor of today’s IRS. Originally, those considered wealthy, with incomes above $10,000 were taxed at a 5% rate while 3% was the standard for incomes above $600. Individuals earning under $600 a year were exempt. Tax collectors were paid a commission of 4% on all money collected up to $100,000 and 2% above that level. These actions lead to widespread abuse and corruption. By 1863, the Bureau of Internal Revenue was firmly entrenched as a strong arm of the Central American government, employing an army of four thousand. Only three years later, however, Congress appointed a Special Revenue Commission charged with reforming the scandal-ridden bureau. In 1872, the income tax was repealed.”[4]

“The income tax has made more liars out of Americans than golf.” – Will Rogers

“The hardest thing in the world to understand is the income tax.” – Albert Einstein

Politicians and the public have long struggled with the idea of income tax and what is a fair amount to pay the government to maintain services. Income tax in the United States would not reappear in earnest until the early twentieth century. “Income tax was seen as being the most efficient means to keep capitalists and monopolists from amassing huge fortunes. Theodore Roosevelt denounced such wealth in 1906 as fortunes swollen beyond all healthy limits.”[5]

Prior to that, the United States Supreme Court issued an exceptionally noteworthy ruling in 1895. The court ruled on a suit brought about by wealthy tax protesters; their claim was that income tax was unconstitutional, as it was not proportioned among all citizens. In other words, a direct tax on the people would have to be equal. This political positioning went back and forth until October 3, 1913, when President Woodrow Wilson signed into law the first personal income tax since the Civil War. Our current income tax can be directly traced to this legislation. Surprisingly however, the tax law passed at that time was only fourteen pages long, in comparison to the almost incomprehensible code that stands today.

With the evolution of tax, methods to shelter income have also metamorphosed. According to the once renowned international accounting firm of Arthur Andersen & Co., the emotions of a tax shelter can be understood within the following context, “The term tax shelter often elicits a strong reaction from those who encounter it. To some, a tax shelter is a giveaway device designed to enrich the high-bracket taxpayer at the expense of the “average” taxpayer. It is a gimmick, a loophole, a proof of Mr. Bumble’s assertion that “. . . the law is an ass. . .” In reality and in fairness, a tax shelter is neither of these. A tax shelter is nothing more than an investment structured to yield the maximum tax benefit from certain provisions incorporated into tax law achieve specific purposes. Whether those purposes encourage specific types of investment, to achieve a social goal or cater to the demands of so-called “special interests” is irrelevant to the investment decision. The incentives are there to be used. They are based on law and are not meant to be measured against standards of fairness or morality.”[6] *

As recently as the 1980s, an ample number of shelters were readily available. Some of these would include tax write-offs of 2-1, 3-1 and possibly greater. The rule of thumb was the greater the write off, the more risk involved in the investment and the higher the potential for IRS scrutiny. Most of these shelters were structured as limited partnerships for oil and gas, real estate, equipment leasing, farming, timber and the motion picture industries. Limited partnerships within the United States, however, had most of their tax incentives eliminated with the tax law change that occurred in 1986. Thus, these investment structures lost much of there allure.

Conclusion

Tax and tax shelters (havens) have existed as long as civilization. They survive in an inverse but directly proportional relationship. Higher taxes will always result in a broader appeal for shelters and havens. Conversely, if a country lowers its tax it will negate the appeal of such alternatives and may in fact become a haven itself. These are dynamic concepts which change with the time, national origin and surrounding economic climate. We would submit that since tax and the inevitable tax shelter do not remain stagnate neither should our understanding of them.

*Arthur Andersen & Co based in Chicago, was once one of the “Big 5” accounting firms however in 2002, the firm voluntarily surrendered its licenses after being found guilty to charges relating to Enron. The Supreme Court overturned the verdict and restored their license. The damage to its reputation, however, has prevented it from returning as a viable business, though it still nominally exists